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SOLUTIONS TO EXERCISES - Princeton University

Princeton University Press . International Finance: Theory Into Practice by Piet Sercu SOLUTIONS TO EXERCISES . magnanimously prepared by Thi Ngoc Tuan Bui, Leuven SB&E. Marian Kane, KBC Bank Fang Liu, Cheung Kong Business School Thi Tuon Van Nguyen, Leuven SB&E. 15:01 on 8 March 2009. 15:01 on 8 March 2009 P. Sercu, SB&E. Foreword Writing the textook itself was an enormous task, over and above my regular work as a teacher, researcher, supervisor and administrator. Fortunately, as far as EXERCISES were concerned I could fall back to a large extent on the predecessor book, Sercu- Uppal's International Financial Markets and the Firm. For many of these, there were even typed-up SOLUTIONS extant, even though I must admit that much of the teacher's manual of that book was mysteriously lost.

6 CHAPTER 2. INTERNATIONAL FINANCE: INSTITUTIONAL BACKGROUND 5. A British importer purchases goods from a French company and obtains a trade credit for the full value of the shipment (equal to GBP 100 ). How should this transaction be recorded in the BOP of the UK? A5. Use: Imports -100; Source: Trade Credit + 100 (short-term inward invest ...

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Transcription of SOLUTIONS TO EXERCISES - Princeton University

1 Princeton University Press . International Finance: Theory Into Practice by Piet Sercu SOLUTIONS TO EXERCISES . magnanimously prepared by Thi Ngoc Tuan Bui, Leuven SB&E. Marian Kane, KBC Bank Fang Liu, Cheung Kong Business School Thi Tuon Van Nguyen, Leuven SB&E. 15:01 on 8 March 2009. 15:01 on 8 March 2009 P. Sercu, SB&E. Foreword Writing the textook itself was an enormous task, over and above my regular work as a teacher, researcher, supervisor and administrator. Fortunately, as far as EXERCISES were concerned I could fall back to a large extent on the predecessor book, Sercu- Uppal's International Financial Markets and the Firm. For many of these, there were even typed-up SOLUTIONS extant, even though I must admit that much of the teacher's manual of that book was mysteriously lost.

2 The bulk of the original work, fteen years ago, had been done by Marian Kane, who was accordingly listed as the 1995. Manual's author. For the revision, I could enlist the help of Thi Ngoc Tuan Bui, Fang Liu, and Thi Tuong Van Nguyen; even R. V. Badrinath provided some questions. I. thank them all very warmly. It seems likely that this set of SOLUTIONS will turn out to be less than per . fect. If you disagree with an answer shown here, please feel free to mail me at thus earning yourself many karma points and, who knows, perhaps even a reincarnation as a professor in Leuven. Blanden, March 8, 2009. i ii 15:01 on 8 March 2009 P. Sercu, SB&E. Contents in Brief 1 Why does the Existence of Borders Matter for Finance?

3 1. 2 International Finance: Institutional Background 3. 3 Spot Markets for Foreign Currency 11. 4 Understanding Forward Exchange Rates for Currency 19. 5 Using Forwards for International Financial Management 27. 6 The Market for Currency Futures 35. 7 Markets for Currency Swaps 43. 8 Currency Options (1): Concepts and Uses 49. 9 Currency Options (2): Hedging and Valuation 63. 10 Do We Know What Makes Forex Markets Tick? 71. 11 Do Forex Markets Themselves See What's Coming? 73. 12 (When) Should a Firm Hedge its Exchange Risk? 75. 13 Measuring Exposure to Exchange Rates 81. 14 Value-at-Risk: Quantifying Overall net Market Risks 93. 15 Managing Credit Risk in International Trade 99. 16 International Fixed-Income Markets 105.

4 17 Segmentation/Integration of Stock Markets 111. 18 Why or when Should we Cross-list our Shares? 113. 19 Setting the Cost of International Capital 115. 20 International Taxation of Foreign Investments 123. 21 Putting it all Together: International Capital Budgeting 137. 22 Negotiating a Joint-Venture Contract: the NPV Perspective 145. iii iv CONTENTS IN BRIEF. 15:01 on 8 March 2009 P. Sercu, SB&E. chapter 1. Why does the Existence of Borders Matter for Finance? [No EXERCISES ]. 1. 2 chapter 1. WHY DOES THE EXISTENCE OF BORDERS MATTER FOR FINANCE? 15:01 on 8 March 2009 P. Sercu, SB&E. chapter 2. International Finance: Institutional Background Quiz Questions True-False Questions 1. If a country has a BOP de cit, the total of all BOP subaccounts is negative.

5 2. The current account is a record of all trade in goods and services, while the capital account is a record of direct and portfolio investment and unilateral transfers. 3. When the us private sector purchases more goods or makes more investments abroad than foreigners purchase or invest in the us during a year, the Federal Reserve (the us central bank) must make up for the shortfall. 4. All errors and omissions in the BOP are a result of black market transactions. 5. When a corporation purchases a company abroad, and the value of the rm appreciates over time, the NII and the capital account of the BOP is updated to re ect this change. 6. The BOP theory of exchange rate determination says that most changes in the exchange rate are due to the arrival of new information about the future.

6 7. Under a xed exchange rate regime, if a country's private sector sells abroad more than it purchases, the central bank must sell foreign exchange. 8. BOP theory is awed is because it assumes that investors only invest in risk- free domestic and foreign assets. 3. 4 chapter 2. INTERNATIONAL FINANCE: INSTITUTIONAL BACKGROUND. A. 1. false; 2. false; 3. true (if investment includes extending short-term credit);. 4. false; 5. false; 6. false (except for information on r and r*); 7. false (the central bank must buy if the KA 0 and CA > 0); 8. true Multiple-Choice Questions For the following three questions, assume that Antarctica is the home country, and its currency is the Antarctica dollar (AAD), and Greenland is the foreign country and its currency is the crown (GRK).

7 Choose the correct answer. 1. All else being equal, an increase in income in Greenland leads to: (a) an increase in consumption in Antarctica, and therefore an increase in imports, resulting in an appreciation of the AAD. (b) a decrease in consumption in Antarctica, and therefore an increase in exports, resulting in a depreciation of the AAD. (c) an increase in consumption in Greenland, and therefore an increase in imports, resulting in an appreciation of the AAD. (d) an increase in consumption in Greenland, and therefore an increase in imports, resulting in a depreciation of the AAD. A1. (c). 2. All else being equal, a decrease in the interest rate r in Greenland leads to: (a) decreased demand for assets in Greenland, and therefore a depreciation of the GRK.

8 (b) decreased demand for assets in Greenland, and therefore a depreciation of the AAD. (c) an increase in consumption in Greenland, and therefore an increase in imports, resulting in an appreciation of the GRK. (d) an increase in consumption in Antarctica, and therefore an increase in exports, resulting in a depreciation of the AAD. A2. (a). 3. All else being equal, a decrease in prices in Greenland leads to: (a) an increase in exports to Antarctica, and therefore an appreciation of the AAD. (b) an increase in exports to Antarctica, and therefore a depreciation of the AAD. (c) an increase in consumption in Greenland, and therefore an increase in imports, resulting in an appreciation of the AAD. (d) a decrease in consumption in Greenland, and therefore a decrease in imports, resulting in a depreciation of the AAD.

9 15:01 on 8 March 2009 P. Sercu, SB&E. 5. A3. (b). Additional Quiz Questions 1. The German subsidiary of a Canadian rm (that is, the subsidiary is owned by the Canadian rm) is sold to a German rm. The Canadian rm invests the funds obtained from the sale in Frankfurt. How is the transaction recorded in the Canadian BOP? A1. Source: outward direct investment (decrease of foreign direct invest . ment); use: outward portfolio investment. 2. The BOP of Timbuktu showed the following entries for 1988: a capital account surplus of 50, a de cit in the services account of 15, and a trade de cit of 45. The change in the o cial reserves was zero. What was the balance of unilateral transfers for Timbuktu? A2. RFX = 0 = usd50 + CA.

10 CA = usd50 = usd45 usd15 + Transfers T = usd10. 3. If the central bank sets an exchange rate that undervalues the foreign currency . and the ows of goods and capital adjust simultaneously what will be the impact on the following: (a) RFX (increase/decrease). (b) BOP (surplus/de cit). A3. (a) The undervalued foreign currency encourages imports and discourages exports to the home country, thus the CA is less than zero. Investment (including foreign direct investment in the export sector) is not attractive, therefore, the KA is likely to be less than 0. The BOP always balances, but CA and KA are likely to be negative, as we saw. (b) Whatever de nition of the BOP you use, there is likely to be a de cit (net out ow).


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